Paul Krugman has a lot in common with quasi-monetarists like me. [Update: I'm going to re-emphasise this. On reading Paul's post, it is now much clearer to me than it was in the past that there is a helluva lot in common between Paul Krugman and quasi-monetarism. So many economists just don't get the central importance of monetary exchange and excess demand for money in understanding recessions. Paul does. Take as read a general rant about such economists.] To oversimplify just a little, we agree on the diagnosis, but disagree on the proposed cure. Which is a bit strange, though not impossible.
Unlike many macroeconomists, Paul Krugman sees that the fact we live in a monetary exchange economy, and not a barter economy, is absolutely central in understanding recessions. A recession is not just a fall in output and employment. A bad harvest or earthquake could do that, even in a barter economy. It is a fall in output and employment accompanied by a generalised excess supply of goods in terms of money. A recession is an excess demand for money. If barter were costless (it obviously isn't) it would be very easy to escape a recession. Unemployed workers would simply barter the labour they cannot sell for the extra goods they could produce but which their potential employers cannot sell. And then the newly-employed bakers could barter their bread-wages for the beer-wages of newly-employed brewers.
Ultimately, I think, Paul Krugman believes that the Paradox of Thrift is really a Paradox of Hoarding. (I reckon I might have misinterpreted him in that old post).
His babysitting model is a Paradox of Hoarding model. That model wouldn't work if they could barter babysitting services, and "money" were just a savings vehicle.
And if you do think of recessions as an essentially monetary phenomena, it's also a bit strange not to propose a monetary cure. Strange, but not impossible.
But what precisely is the underlying difference between the cure Paul Krguman would propose and a monetary policy cure?
Paul Krugman would, I think, want US Nominal GDP to be (say) 5% higher than it is right now, and then grow at (say) 5% per year thereafter. I don't think there would be much disagreement between Paul Krugman and (say) Scott Sumner over the precise numbers. Or even over the target variable itself. In any case, both would agree that something even vaguely like that would be much better than what the US has right now.
And if that's what you want monetary and/or fiscal policymakers to do, why not have them announce it, make it a commitment, that they will do as much as is necessary for as long as is necessary to hit that target? Paul Krugman would agree that expectations of higher NGDP would help the US escape recession. His model says so.
OK. The difference is on the means used to hit that target and fulfill that commitment. Paul would I think want a policy like:
1. The Fed prints money and Treasury uses that money to build a new bridge.
OK. Let's start there.
2. Any objection if they charge a toll on the bridge (subject to demand and collection costs)? The revenue from tolls could always be spent on other worthwhile government things, if you think that's a good use of the funds, from either micro or macro grounds.
3. Any objection if Treasury sells that bridge at a later date, and returns the money to the Fed, once the NGDP target has been hit, and there's a danger of overshooting the target? It would be good to make this policy reversible.
4. Any objection if the management of the bridge and collecting the tolls were turned over to the private sector? Or rather, any objection on purely macroeconomic grounds?
5. Any objection if the bridge is built, owned, and operated by the private sector, and the government just buys all the shares and collects the dividends?
6. Any objection if the government instead buys 50% of the shares in two new bridges, rather than 100% of the shares in one new bridge?
7. Any objection if the government buys commercial bonds in new bridges, rather than shares? Make the private owners the residual claimant, so they have the incentive to do their job right?
8. Any objection if we extend this to all new investment projects, not just bridges?
9. Any objection if we allow the Fed/Treasury to buy some old investment projects instead of just new ones? There's presumably high substitutibility between old and new investment projects, so the previous owners of the old investment projects will go looking for new ones with their new cash?
If there's no objection so far, then the cure for the recession is for the Fed and Treasury to announce a joint commitment to a level-path for NGDP, and to implement that policy by buying commercial paper with freshly-printed money.
Want to go the final step and have the Fed alone buy government bonds, on the grounds that government bonds are close substitutes for commercial bonds?
Or, maybe back up a little, and get Treasury to allow the Fed to buy the S&P 500 index? That's definitely OK by me.
Where exactly does fiscal policy end and monetary policy begin? (Not sure I know the answer to that one).
What is the real underlying difference between Paul Krugman and quasi-monetarists?
(It can't be just pessimism/optimism on the ability of monetary authorities to make credible commitments, can it?.)
Worthwhile Canadian Initiative 
I suspect Krugman’s political viewpoints are in part guiding his economic ones. In particular, he appears to desire a far larger role for government in the economy, and is becoming increasingly hostile to “unfettered capitalism”.
rabbit: maybe. But perhaps the same thing could also be said about Scott Sumner, or me.
fed buy S&P, not sure who really benefits on that front.. we have already had paper/fake asset inflation and it has only widened wealth gaps and hurt small businesses even more. I fail to see where inflating paper assets and closing output gaps have anything to do with one another. That type of thinking is just another fake monetary policy tool, haven’t we established this is a fiscal policy problem not a monetary one?
Very good, indeed.
I´m jus have read this paper of Friedman I suppose you know (http://nb.vse.cz/~BARTONP/mae911/friedman.pdf), wich I see as a perfect complement for your text.
The problem is that the paper is from 1948, when Milton was for the 100% reserve banks. But his propposal of a financial debt without interest is brilliant, I think. It is the best “authomatic stabiliser” I never see. Do you think that his condition of 100% is absolutely necessary?
Could their be something to do with the certainty of governement spending on such projects?
With the construction labor market facing so much uncertainty, the bridge project alone may be more efficiently built/run privately, but knowing that regardless of external economic conditions or internal company conditions, this bridge will be built, might that not also have indirect effects to those benefiting from its construction?
I guess given curent conditions that would lead me to think before agreeing to point #5.
Paul: are you really that certain that a government project won’t have its funding cancelled? See also: tea party.
“Paul Krugman would, I think, want US Nominal GDP to be (say) 5% higher than it is right now, and then grow at (say) 5% per year thereafter. I don’t think there would be much disagreement between Paul Krugman and (say) Scott Sumner over the precise numbers. Or even over the target variable itself. In any case, both would agree that something even vaguely like that would be much better than what the US has right now.”
I didnt have much attention to pay attention to Scott Sumner’s blog when he was proposing this method but are there any good resources for understanding this view? Is there any evidence that it will work? What happens if it only works temorarily and wears off once investors inflation expectations adjust? Are we then going to argue that we should try a 10%/yr target? I just dont really understand how an economist like Scott Sumner can propose something like this without having at least some fear that it will set off inflation at some point (or stagflation). Can somone explain this, I would really be interested in understanding their point of view.
How about this: Let’s do lots of #1 (doesn’t have to just be bridges), and in the meantime you guys can go argue about 2 thru 9. We’ll stop when you get it figured out. Deal?
🙂
“It can’t be just pessimism/optimism on the ability of monetary authorities to make credible commitments, can it?”
Why can’t it? Decades ago Krugman was writing about the role of credibility in exchange-rate policy. And he never had a problem with letting the Fed take care of demand management as long as the ZLB was far away.
Nick In his next post PK shows that the IMF indicates the “Confidence Fairy is dead”, i.e. that Fiscal Consolidation is contractionary.
But then, I think:
Fiscal Consolidation is contractionary, especially if monetary policy is also \”non stimulative\”. But note that fiscal stimulus was also \”non expansionary\” because monetary policy was, in fact, contractionary!
So, instead of giving up on monetary policy back in early 2009 to go \”all in\” for fiscal stimulus, mostly to \”peddle\” your liquidity trap view, you should have used your colums to \”cry out\” for more aggressive monetary action, especially since at the time inflation was completely absent!
Nick:
“What is the real underlying difference between Paul Krugman and quasi-monetarists?”
It is the distribution of debt. When people focusing on rebuilding their balance sheet the best monetary policy can do is ‘reduce’ that debt through inflation.
You [the QM’s or MM’s) never talk about a balance sheet recession (I nearly said BS recession), Krugman following Koo does. How does QM look at a balance sheet recession: a reduction in real spending to reduce debt? Because of the balance sheet recession, the demand for money is a symptom, just look at the kantooseconomics site http://kantooseconomics.com/2011/09/12/mein-unbehagen-mit-quasi-monetarismus-my-discomfort-with-quasi-monetarism/#English%20version
he basically agrees with that.
Nick: 1 ( yes Patrick lots of 1!) through 8 is almost non-controversial, But at 9, you’re back at possible cash hoarding. Especially if the former bridge owner thinks like the owner of the London-to-York railway.
The CP purchase option mentioned above depends as well on businesses being credit constrained: they see lots of profitable opportunities, they’d employ more if they could, they just can’t get financing. Instead they’re acting like households — paying down debt, cash-rich.
The bridge example would work if infrastructure was largely private. But the network externality means that on the margin building new infrastructure isn’t profitable, most of the gains accrue to holders of existing infrastructure (we, the people). Of course the Fed could purchase debt in projects that are not (at least by them, in private) expected to be profitable. But legal and political strictures are formidable, and in practice it may create jobs but not the benefits of infrastructure. I for example lived along an old national road in rural Japan that paralleled a new limited-access highway. But the tolls were so high on the latter that few used it. So the bonds used to finance the construction will (eventually) prove to be worth a fraction of their face value (they were purchased by the postal savings system) and the economic benefits are nil, once the job creation of the construction period passes. Furthermore, that sort of system is begging for abuse, and was abused, so it wasn’t even very good at creating jobs.
This digresses from the formal theory, but it does suggest that (indirect) monetary policy [critical proviso] in the face of a zero lower bound is ineffective, given even a modicum of controls that keep it from being a near-transparent version of fiscal policy.
“Any objection if they charge a toll on the bridge?”
Yes, assuming the toll “proceeds” go to the government. A toll has the same effect as a tax of transfering financial wealth from the private sector to the government sector. Our goal is directly the opposite – to increase private sector wealth.
“Where exactly does fiscal policy end and monetary policy begin?”
The Fed engages in contractionary fiscal policy any time it makes a “profit.”
The Fed engages in expansionary fiscal policy any time it makes a “loss.”
The Fed engages in monetary policy any time it breaks even (or if you like, any time it comes reasonably close to breaking even).
Given the current state of the economy, any time the Fed makes a “profit” it is a national tragedy, while any time the Fed makes a “loss” that is cause for tremendous celebration.
Now, let’s take your last suggestion of the Fed buying the S&P 500 Index – SPY is currently at 118.
Supposing that the Fed posted a bunch of bids to buy SPY at $150, that would be great – especially if they then followed up by selling their SPF shares back to the market at $118. Why would that be great? Because the Fed would be making a “loss.”
Alternatively, suppose that the Fed posted a bunch of bids to buy SPY at $118, that would be ok. It would become fantastic if the next day then the next day they sold all their SPYs at $1. Why would that be great? Because the Fed would be making a “loss.”
But I would suggest that buying SPYs is not the most equitable, fair, or effective way to do this – people who own stocks tend to be much wealthier than the average citizen and have lower than average propensities to consume or pay down debt. It would be much better to just mail all citizens a check, and dispense with the charade of taking an asset in return.
The main objection to each progression is: yes, that might work, but it’s less likely to work.
Also, if you really want to use expectation effects, what you want is a stimulus program which is obviously too large and effective. “If this doesn’t work, we will do more of the same” is not very credible.
alex – I’m more defending the possibility that this type of government expenditure could be more useful now, then predicting that it would be useful. The gov’t at least in theory should be able to to take a longer term and large scale approach to spending and infrastructure investment then private buisnesses.
While most of the time these processess may be more efficient by channeling much of the operation through private channels, agreeing with what Nick stated above. I think in the current situation, having a gov’t that can do the process start to finish (and do it fairly well), certainly until number 3, would be best. That isn’t to say it could do it fairly well.
He’d object at number 9 and everything following, unless the first 8 were exhausted. The key qualifier is “new”. That’s fiscal. “Old” is monetary.
I believe Krugman has said that in order to move the needle on NGDP or inflation a meaningful amount under current conditions would involve such a vast issuance of money as to be impossible as a practical matter.
Amateur question: Don’t we object to number 2? If the goal is to add money, create a bit of inflation because it is too low, and build something useful, then charging a toll before the economy improves seems counter productive.
No, as Kling & Hayek & Mankiw point out, ia tradype cycke is a dis-coordinated economy, most especially in the areas of invedtment / capital and labor — items which to a limited degree are substitutes, but which are specialize and don’t fit when the economy is in severe discoordination — some items, like lumber hauling rail cars & CDSs & houses — lose their prior value status, which was dependent on an unsustainable equilibrium.
Insisting on ignoring an empirical pattern staring you in the face, because “theory” won’t allow to to think it, is not a competent strategy for a scientist.
Nick writes,
“It is a fall in output and employment accompanied by a generalised excess supply of goods in terms of money.”
Sorry for the Ipad typos …
Nick,
I think it’s quite sensible to believe that government command spending can do things (build bridges) that the private sector would not do, if monetary policy conducted by Fed buying corporate equity and commercial debt. You don’t have to think government run economies are good ideas to think that in some circumstance, a bit of command and control can be useful.
Here’s something that has been puzzling me, would be grateful for your thoughts.
If we did want to monetize government debt to enable some fiscal stimulus, the Fed could buy debt and announce it plans to roll that debt over in perpetuity so everybody can regard it as written off, and the real government debt (that will ever need repaying) has shrunk. So the only difference between that and QE is the intention to roll over, rather than sell back to the private sector in due course. Its puzzling because the only difference between supposedly non-inflation stocking QE and supposedly inflation exploding Zimbabwe style monetizing debt concerns future intentions.
Why are discussions about doing more monetary stimulus always about buying more, as opposed to changing what the Fed plans to do with what it has already bought? If it wants to create a bit of NGDP growth, and thinks some fiscal elbow room would be useful, why isn’t there explicit talk of monetizing (writing-off) some portion of what’s already on the balance sheet? And … what do we know, and how do we know it, about the relationship between funding government spending via the printing presses, and inflation, in the current circumstances? How much could we get away with, how responsive is inflation to it?
This is a lingustic stipulation, it’s not a fact of reality:
“A recession is an excess demand for money.”
It’s you attempting to legislate a use of an essentially contested word.
Everyone else is free to say, “Bunk”.
Money, credit, leverage etc. allow an economy to discoordinate the structure of production across time — e.g housing finance & housing construction & housing manufacturing support capital, etc. — this massive discoordination of the interconnection of production and consumption will but specialized goods out of work, looking for a valued place in the re-eqypuilivrating system.
Some of these will never find a new place of values use — value greater than cost of their productive exploitation.
This is Econ 101, but econ 101 is banned from macroeconomics due to the stipulated dogma of your definition of
“recession” and due to the bogus causal entites of aggregated GDP, aggregated labor, aggregated capital, etc. which are pretended to directly interact the “tool kit” everdya macro models stuck in the head of macroeconomic “scientists”.
Patrick: we can do 9 much quicker than anyone can do 1.
JKH: suppose the government buys a brand new office chair. That’s fiscal. Suppose it buys a chair that was produced 5 minutes ago? 5 hours ago? 5 days? 5 weeks? 5 months? 5 years? 50 years? Someone’s got the cash, and will want to replace the chair.
Mattay: So if the Fed bought the S&P500, and this caused the economy to recover, and S&P profits to increase, and the value of the S&P500 to increase, so the Fed sold them back during a boom at a profit, that would be a failure? There’s more to economic policy than income (wealth) effects.
A balance-sheet recession is state-space stable. That means that once the state condition is in place (businesses want to pay down debt and hoard cash rather than invest) it is stable, sticky, persistent and won’t change unless we change the state-space parameters.
It means he economy is money-constrained instead of capacity constrained. It also means additional investment to expand capacity is useless.
In order to change the state-space condition you need to inject money into the economy. We need money supply inflation, which because of the balance-sheet recession state will not lead to price level inflation, the kind of inflation everybody hates.
Once we are back to a capacity-constrained economy which needs investment to expand to meet demand and can use that investment, then we can worry about price inflation.
Additional investment in a balance-sheet recession is only useful as a method to deliver money. It works because it’s an acceptable method to reach households. Remember in our economy we distribute wealth through wages and employment. The investment is a delivery vehicle for added money, not an end in itself.
Balance-sheet recessions turn some fundamental conditions of a normal capacity-constrained economy upside down. The fact that it does and these are not conditions we normally encounter is what makes the solution so difficult because the methods are atypical, counter-intuitive and are inappropriate for a normal capacity-constrained economy.
Martin: David Beckworth has done a number of posts on the balance sheet recession theory. I have addressed it too, obliquely. Whenever I do weird posts on antique furniture and the Pro-usury party I talking about whether an excess of desired saving can cause a recession. And Richard Koo’s theory is that a balance sheet recession is when creditors stop lending, and borrowers stop borrowing, and this (somehow) causes an increase in aggregate desired saving and this (somehow) causes a recession.
“There’s presumably high substitutibility between old and new investment projects, so the previous owners of the old investment projects will go looking for new ones with their new cash?”
Sounds like an assertion that investors are just as likely to use cash to fund new projects during bad times as during good. I don’t buy it.
Luis Enrique: “If we did want to monetize government debt to enable some fiscal stimulus, the Fed could buy debt and announce it plans to roll that debt over in perpetuity so everybody can regard it as written off”
You need to be very clear on exactly what you mean. If you are paying interest on excess reserves then you are just replacing long term debt with short term debt – Operation Twist. I don’t think that’s what you mean.
If you are not paying IOR, then you cannot raise interbank lending rates above zero until you have removed the excess reserves. Otherwise there would be no bid for settlement balances, and the CB would lose the ability to control the marginal cost of funds for commercial banks. So a commitment to permanent QE is a commitment eternal ZIRP. It’s not credible.
The basic problem is that there is a very limited demand for non-interest bearing money when interest rates are not at zero – just basic liquidity requirements. You can’t will there to be arbitrarily large amounts of it (or the risk free rate will collapse).
Rpwe:
“But perhaps the same thing could also be said about Scott Sumner, or me.”
Or anyone.
But unlikely to the degree that Krugman has. He is showing increasing signs of bitterness, polarization, and contempt for those who disagree with. It’s not a pretty sight.
“Any objection if the government buys commercial bonds in new bridges, rather than shares?”
Yes, I object. When interest rates are very low, bonds are a fairly close substitute for money, while real investment is not. Buying the bonds therefore won’t necessarily result in more bridges being built; it might just result in more household assets being held as money rather than bonds. (I’ll grant you it would probably work if the government buys enough bonds, but the number required might be quite huge relative to the amount of new investment created.)
Of course we’ve had this argument before, and your answer is something like:
“maybe back up a little, and get Treasury to allow the Fed to buy the S&P 500 index”
which is fine with me and probably with Paul Krugman as well, though many (perhaps including him) will object that this is now fiscal policy rather than monetary policy. His larger point, though, would be
“that the quasi-monetarists are trying too hard to find a deep essence when what’s really needed is just a model.”
And here I’m going to switch and put my quasi-monetarist hat on. I think there’s a good reason for trying to find a deep essence. It’s a political issue: Paul Krugman is saying, “Hey, let us technocrats take care of it, since we have a model that works well enough.” That’s not going to fly, because people don’t trust technocrats. If you can find an essence, you can perhaps get people to see that it really is the essence, and there is some hope of getting them to realize that there is a monetary problem that requires a monetary solution (although the monetary solution could take the form of a fiscal policy designed to reduce the demand for money).
Chris J: there is nothing to prevent the government taking that toll money and putting it right back into the economy, either to finance more bridges, or handouts, or tax cuts, or whatever. If it’s needed. The Bank of Canada’s income from past money creation gets handed right back to the government in any case. Or, set the toll at $0 till the recession is over, if you like. Or hand it back to the drivers as they exit the bridge! It doesn’t matter. But it’s important that the government can collect the toll revenues and use them to retire debt and/or money when the recession is over. And those potential future toll revenues are what allow the government to sell the bridge and get its money back when the recession is over and it needs to reverse policy.
@Greg Ransom:
That’s sounds a bit Austrian. I derived my balance-sheet recession position from Roger Garrison’s Time and Money model. If you treat the Loanable Funds market as the money supply and draw a circle around it to show the size of the money supply and assume a monetary economy where all trades are for money, then you can easily get monetary disequilibrium and make the model demonstrate a balance-sheet recession with an output gap.
Sure it is degenerate behaviour but it is plausible and self-consistent. As an engineer by training I have learned to accept suboptimal and degenerate cases.
Nick’s definition is simply declaring a frame-of-reference. In physics there is no preferred frame of reference so you always have to define your own. In monetary economics that preferred frame of reference is money. A shortage of money is a demand deficiency which is also the same as glut of good relative to money. It all depends on which frame of reference you use, goods or money.
Goods to goods is not a valid frame of reference in this debate.
Martin,
What is the difference between a balance sheet recession and a rise in the demand for base money? Here’s what I think: a balance sheet recession is when the public try to rebalance their debts. This drives up the demand to hold money i.e. people want to save more and borrow less. However, unless the money supply is increases to match demand, they will be frustrated in their efforts through debt deflation. A balance sheet recession is just a way that you can get a disequilibrium between the supply & the demand for money. It is wrong to separate the former from the latter.
The monetary disequilibrium IS the cold. It is not a symptom. The balance sheet problems are just how the cold is caused, but there are many ways of getting a cold. It just happens to be the case that, while there is no cure for the cold, there is a cure for monetary disequilibrium.
(A different case of demand-side monetary disequilibrium might be something like interest rates on excess reserves, which increase the demand for to hold base money.)
@Nick, I believe Richard Koo focuses mostly on that borrowers do not want to borrow because they want to minimize debt and that this behavior – debt minimization – depresses spending and this depresses AD. The creditors in this instance are the banks that accumulate cash on their balance sheets: I believe Nomura had about 17% Equity. The job of the government is to mop up those savings and to spend them, because banks cannot find anyone else to borrow. That is how this is supposed to cause a recession.
I believe he also argued that the spending gap was quite large 10-20% of GDP that was filled with a modest amount of stimulus in Japan.
As I understand MM, the BOJ should have announced an NGDP target and done everything to reach it. If there however is a spending gap of 10-20%, how much inflation is that going to generate from a year to year basis? I know it must be less than 10-20% as it also makes taking out credit more attractive, but how much can you expect with such a gap?
Nick said:
“So if the Fed bought the S&P500, and this caused the economy to recover, and S&P profits to increase, and the value of the S&P500 to increase, so the Fed sold them back during a boom at a profit, that would be a failure? There’s more to economic policy than income (wealth) effects.”
Your hypothetical scenario sounds great to me. If the outcome that you describe did indeed occur, that would be wonderful. To be clear, I have no real objection to trying it. I simply don’t understand why it would work, beyond the fiscal effects that could stem from fed “losses.”
What mechanism would cause this hypothetical fed fueled recovery to actually occur?
@W Peden:
“What is the difference between a balance sheet recession and a rise in the demand for base money? Here’s what I think: a balance sheet recession is when the public try to rebalance their debts. This drives up the demand to hold money i.e. people want to save more and borrow less. However, unless the money supply is increases to match demand, they will be frustrated in their efforts through debt deflation. A balance sheet recession is just a way that you can get a disequilibrium between the supply & the demand for money. It is wrong to separate the former from the latter.”
Let’s say it does, off-setting that demand, however does not mean you have solved the balance sheet recession, you have merely prevented a secular depression. It just hasn’t gotten worse, but the problem is still there.
Martin,
Assume money isn’t in disequilibrium and the public as a whole try save more (for whatever reason). Two things can happen: (1) the cost of financing government expenditure falls as the demand to borrow from the government rises; or (2) the public adjust their desire to save and borrow in line with their new money balances (Fisher’s dance of the dollar). Either way, the debt deflation cycle has ended with the increase in the money supply, because debt deflation only holds if people can only reduce their balances with existing money.
Hence there have been recoveries from severe deflationary recessions (like Britain after September 1931) with tight fiscal policies with compensating monetary policies. Monetary disequilibrium models have a very good explanation of why something like that would happen.
K
You are talking about things I’m not sure I understand. I had in mind something simple. If I lend you $10 and then every time you repay it, I lend you another $10, that debt is effectively written off. The Fed can do that*. You say it’s “not credible” … I don’t think by that you mean we could go ahead and use the printing presses to finance government debt with no consequences for NGDP.
* indeed it doest that. Over the long run, that’s how it realises net new money into the economy, by bringing govt debt onto it’s balance sheet and keeping it there.
I obviously can’t speak for Krugman, but more me:
(It can’t be just pessimism/optimism on the ability of monetary authorities to make credible commitments, can it?.)
… is indeed critical, especially at or near the zero bound.
Further, the key step in your example is 6. From step 6 one needs a private agent willing to spend cash on stuff rather than hoarding it – and in a liquidity trap one may not find that agent. By contrast, pure government spending translates directly into demand and creates shortages in goods markets. Thus it always works – as long as the government has capacity to indebt itself – while monetary policy may not.
W. Peden,
I disagree, your argument seems to be premised on the idea that you can only have a debt-problem when there is debt-deflation. When debt is outpacing NGDP growth, then you will have a debt problem in the future without it being caused by debt-deflation. Worsened, yes, caused no.
Did anyone read the comments on Krugman in the NYT?
Yikes!
Martin,
Fair point. I should have distinguished more clearly between debt deflation (which is sustaining disequilibrium within a recession) and a balance sheet recession (which can cause a recession). The way that monetary equilibrium solves them both is the same though: the increase in the money supply solves the monetary disequilibrium, and in monetary equilibrium one person’s rebalancing is another person’s profits.
I certainly don’t want to say that debt is only a problem when there is debt deflation (or any sort of deflation). I do think that debt-rebalancing is turned into a benign and stabilising process by monetary equilbrium. The first half of Great Moderation in the UK was basically a story of people rebalancing their portfolios after the early 1990s housing bust. It was a period of astonishing stability in output, falling unemployment, and inflation between about 1.5% and 3.5%. The rebalancing of portfolios through paying off debt was totally commensurate with this stability. (Incidentally, fiscal policy slowly tightened over this period, leading to surpluses in the late 1990s.)
Luis Enrique: I’m going to (slightly) take back what I said (but not materially :-). A commitment to perpetual QE is not a commitment to perpetual ZIRB. Reasonably there is some equilibrium ratio of quantity of money, M, to NGDP (It’s one over the velocity of money). So a commitment to maintaining a particular value of M, is a commitment to maintaining ZIRP until inflation/growth has rendered NGDP up to the equilibrium level implied the that value of M. So lets say we doubled M since last time the economy was at a reasonable equilibrium (2007ish) and commit to keeping it there. Then we are saying we are going to keep rates at zero until inflation/growth has doubled NGDP. That is not credible. Maybe if we had increased the money supply by, e.g., 20% then that would be a reasonable commitment. Maybe they should increase reserves by 5% each year and promise never to decrease them.
But then are we really not just back in the contingent path of rates game? It’s just a commitment not to increase rates above zero until NGDP, inflation, whatever, is at some target. M has nothing to do with it cause it’s not doing anything anyways while we are at the ZIRB. The only relevant action is the announcement of the conditions under which we exit the ZIRB (and the contingent path of rates thereafter). The market doesn’t care one iota about M in the meanwhile.
Bill, as always – you are so right! Yikes!
Henry: “From step 6 one needs a private agent willing to spend cash on stuff rather than hoarding it – and in a liquidity trap one may not find that agent. By contrast, pure government spending translates directly into demand and creates shortages in goods markets.”
Suppose we had a Keynesian and a Monetarist arguing like this:
Keynesian: “Y=C+I+G+NX. Therefore if G goes up, Y directly goes up. (Unless there’s some weird offsetting effect through C, I, or NX).”
Monetarist: “MV=PY. Therefore if M goes up, Y directly goes up. (Unless there’s some weird offsetting effect through V or P.)”
Why should it matter whether the government buys 100% of 1 new bridge or 50% of 2 new bridges, in consortium with private partners? You might argue that 2 extra bridges get built in the second case. It all depends what those partners would have done otherwise. But you also wonder what everybody else would have done otherwise in the first case.
Bill, Lars: which comments? As usual there were a lot of comments from people who don’t know much economics, criticising both quasi-monetarism and Paul Krugman from all sorts of directions, right and left.
Nick, its Market Monetarism;-)
But we are talking about the comments you did your blog on…so I guess you are covered.
@W. Peden,
I agree with you on the monetary equilibrium, the monetary authorities should do their utmost to maintain this. However how benign re-balancing is going to be seems to depend on the amount of debt and how it is distributed in the system.
I also do not think that you need NGDP to be on target for there to be a monetary equilibrium and the desirability of NGDP being on target when there is a debt re-balancing depends on the amount of inflation that is going to accompany this. This seems to depend on what the stance of fiscal policy is and how much debt is depressing spending.
In case of the UK, I think that improved macro-economic conditions in the world made it possible for the UK to export its way out of that mess: http://research.stlouisfed.org/fredgraph.png?g=2bo This, is what probably allowed them to tighten.
Martin,
I don’t know about that. I suspect that world conditions were more favourable in the 1960s, on balance, but we managed to get ourselves into accelerating unemployment and inflation during that period. What was really important was (a) better supply-side policy and (b) better demand-side policy. The former made sustainable low unemployment possible, the latter kept inflation in check. Also, there’s no theoretical reason (that I know of) which would preclude doing what the UK did in an autarkic economy.
And while macro-economic conditions improved in the world during that period, few countries improved as much as the UK. Some of the best were those engaging in fiscal tightening e.g. the US during the late 1990s.
As for NGDP being on target requiring inflation, what fundamental difference is there between paying off debt out of increasing real incomes and paying off debt due to inflation?